According to Matthew Ledvina:- It can be a difficult situation to decide the next step while facing with the cross-border tax issues and its various risks. For such problems, Foreign Grantor Trust (FGT) is the solution commonly used. This article will deal with the basics of FGT which are needed to know.
What is the Foreign Grantor Trust (FGT)?
A Foreign Grantor Trust (FGT) is not reflected as a US domestic trust, by which it means that the trust and the trustees will not pay tax in the US.
Who are FGTs for?
Foreign Grantor Trusts are used when a non-US individual or foreign resident intends to financially help US taxpaying residents through a trust fund. For example, a citizen of Singapore (grantor/settlor) wants to help his/her grandchildren who are taxpayers in the US to avoid paying taxes.
Common mistakes made with FGT
There are a number of tax benefits with the FGT approach, however, things can become complex if the settlor of the trust passes away. Therefore, it is necessary to consider the local tax laws as well as the tax codes for non-US taxpaying residents or else it can result in severe financial penalties in the long run.
Types of FGT
There are two types of Foreign Grantor Trusts:
- Revocable Trust– It is the first option that allows the US beneficiaries directly to avoid taxes via FGT during the settlor’s lifetime. The beneficiaries need to make sure to report the trust to the IRS for the purpose of record-keeping.
- Irrevocable Trust– In this, the beneficiary does not benefit directly from the trust, but can receive unlimited tax-free gifts from the settlor or their partner. It is only needed to be reported to the IRS if the annual amount of gift exceeds 100,000 USD.
It is tough to choose between the two, so one requires research beforehand from all the parties to make the best of the settlor’s local tax code and the US system.
Pros of FGT
The main advantage of FGT was to legally avoid taxes, paying as little as possible. This allows the next generation to benefit from the money their grandparents have already amassed and paid taxes on. The settlor incurs US taxes on a few categories such as US source dividends (shares in US companies). They were exempted from most of the other asset classes, but long-term planning is essential to ensure trust does not get subjected to US taxation inadvertently.
Cons of FGT
FGTs work well during the settlor’s lifetime but become complex his/her death. The special US tax status ends at this point and FGT automatically converts into Foreign Non-Grantor Trust (FNGT). However, there is a number of strategies that are put up in advance to avoid such a situation.
Solutions for FNGT US Beneficiaries
The following are the common strategies employed to minimize the tax due to US beneficiaries while receiving funds from FNGT:
- Structure the FNGT in such a way that it pays the annual income and capital gains to the US resident’s trust or the beneficiary. This will prevent the accumulation of a large amount of income and gains which would otherwise incur a substantial US tax Bill.
- Convert the FNGT to a complete US resident’s trust so that it can be entitled as a domestic trust. Then there would be no need to pay annual benefits to minimize tax.
- The easiest strategy can be to close it down and distribute the money among the beneficiaries.
The choice of the approach is very much dependent on the situation and will be highly influenced by the resident status of the parties involved. Planning is the key point here along with the knowledge and especially the cross-border implications at every turn.